How to Retire By 55 (or Sooner) on a Salary of $50,000 or Less

How-to-Retire-by-Age-55If you’ve got dreams of retiring early by age 55 or sooner, then you’ll be very delighted to know that this goal is well within your reach!

Believe it or not, our ability to reach financial independence is something that is always possible to achieve.

Though the path to get there may not always be clear, there are always certain actions we can take that will cut through the brush and reveal a clearing at the end of the forest.

The biggest question and sometimes most challenging obstacle: How?

You might think that the dream of financial freedom is something that is only reserved for the rich or those who make over $100,000 per year.  But I can tell you that a lot of the same tricks work even if you make much less than that.

In this post I’m going to create a roadmap for early retirement for someone who wants to know: How can I retire at age 55 or sooner?  AND thanks to a challenge from my friend from Angry Retail Banker, we’re going to do it assuming your household makes $50,000 or less per year.

An income of $50,000 or so per year is not that uncommon in America.  In fact according to a 2014 report from CNN, the median household income of America was only $53,891.

To start, let’s consider what an income of $50,000 actually looks like.

Defining Your Standard of Living:

Because this post will be one out of a million different ways you could create a solid early retirement plan, we’ll have to lay down a few ground rules and assumptions.

My first assumption is that you’ll want to continue to enjoy whatever quality of life you’re currently enjoying right now.  That means that by age 55 or whenever we’re able to retire, you’ll be making approximately the same net take-home pay.  No more and certainly no less.

To do this, the first thing we’ll need to understand is how much money are we really living off of?

In other words, if you make$50,000 per year, are you really living off of $50,000?  Of course not!  It’s less because you have to subtract away taxes and 401k contributions.

Let’s get an idea of exactly how much:

  • Start with a gross income of $50,000 per year.
  • Subtract your 401k contribution. 401k’s are the most common form of tax-sheltered savings currently in America.  So in this example we’ll assume you have one.  The average recommended savings rate is 10%.  That means we’ll stashing $5,000 per year.
  • Subtract Federal taxes. Your annual Federal taxes are calculated by taking your gross income, subtracting away your 401k contribution, a standard deduction, and two personal exemptions (in this example we’ll assume you’re married and filing jointly).  After all that, we’re left with a taxable income of $24,700.  Using our tax bracket system, that calculates out to $2,798 in Federal taxes for the year.
  • Subtract away Social Security / FICA taxes. At 6.2%, that’s $3,100.
  • Subtract away Medicare taxes. At 1.45%, that’s $725.
  • (We’re going to ignore State taxes because there are too many variations to consider. For simplicity I’ll just have to assume this is one of your expenses you’ll cover with your net pay.)

Putting all of that together, that works out to a current net take-home pay of $38,378 per year (or $3,198 per month).

What is Our Target Retirement Income?

The first thing you have to understand about the future is that inflation makes everything more expensive.  Obviously you already know this because things you buy today probably cost you more than they did a few years ago.

Fortunately for you in this example we’re going to be doing our calculations with inflation adjusted returns, so no worries!  That means we’ll assume that $38,378 today has the same purchasing power it will whether we’re looking at 20, 30, or even 40 years from now.

So is our target retirement income $38,378?  Nope.  Remember that you’ll to pay taxes on your 401k income when you retire.  So we’re going to need more than $38,378 per year to live on.

We can figure this out very simply using the Federal taxes line we just calculated above:

$38,378 + $2,798 = $41,175

Notice something?   You can ignore Social Security / FICA and Medicare taxes in the future!  That’s because these are taxes you pay on your employment income, not on your savings.

What is Our Target Nest Egg Size?

Using the ole-stand-by safe withdrawal rate of 4 percent, our nest egg is going to need to have:

$41,175 / 0.04 = $1,029,375

How Many Years Will We Have to Save?

Now the big question: How long is it theoretically going to take to get there?

In order to figure that out, we’ll need to consider 2 main factors:

  1. The estimated return rate on our investments.
  2. Our annual savings.

Return rate.  We can make this one really simple and assume you’re investing in a common stock index fund.  According to NYU, such a fund would have an average annualized return rate of 9.84%.

Now remember that we said we’re going to adjust our example for inflation.  Inflation is roughly 3% per year.

So to figure out the true rate of return on our investments every year, we subtract:

9.84 – 3.0 = 6.84%

Annual savings.  Above we already started off by saying we’re going to save 10% in our 401k every year.  We could assume that our salary is going to go up every year, but I’ve got some bad news.  “Most” raises are only 3% or so; just enough to keep up with the rate of inflation.  So since our example is inflation adjusted, 3% – 3% = 0% increase in purchasing power every year.  In other words, we’ll keep that $50,000 income the same throughout this example.

Now the good news is that in addition to your savings there’s one more thing we haven’t considered that really helps us out each year: Our 401k employer match!

401k employer matching plans are as far and wide as you can imagine.  So for simplicity we’ll use the average reported figure of 3% of your salary:

$50,000 x 0.03 = $1,500

Combining our 401k employer match with our own savings, that’s:

$1,500 + $5,000 = $6,500

How many years?  Combining a savings of $6,500 with a return rate of 6.84%/year, how long will it take us to accumulate our target nest egg of $1,029,375?

The answer: 37.3 years

WAIT!

Stoic-Abe-Five-Dollar-Bill-e1429489128873That’s no good!  If you had started working at age 25, that means you won’t have enough money to retire until you’re age 62.3.  MMD: You didn’t accomplish your goal!

I did this on purpose to show you how the “conventional” way of saving for retirement is rigged.  After going through this example, is it any wonder that the “average” savings rate in a 401k is 10% and the “average” age of retirement in America is 62?

Did you see how that math played out perfectly?

Unfortunately, if you REALLY want to achieve an early retirement, you’re going to have to do a little bit better.  You’re going to have to make some sacrifices to get what you want.

But fortunately it’s not going to be as bad you think.  Here’s a few variations that I think you’ll enjoy.

Changing Our Savings Rate:

Using exactly the same parameters as we did in the above example, let’s see how we can get our “number of years of saving” down from 37.3 to 30 or lower.  That would put us at age 25 + 30 = 55.

To this, we only need to change one variable: Our 401k savings rate.

By going from a 10% to an 18% savings rate, this drops our “net income” down to $34,978.  In other words, if all you ever knew was an income of $34,978, you’d learn to make your life work at this amount.

That changes our target nest egg goal to $929,375.  And by doing that it now only takes us 29.5 years to save up that much.

Success!!

But why stop there?

If you can make your life work for less than $34,978, let’s keep playing out the numbers:

  • A savings rate of 25% would drop your number of years down to 24.7.
  • A savings rate of 34% would drop your number of years down to 19.8.
  • A savings rate of 45% would drop your number of years down to 14.9. (Note to accomplish this you’d have to max out an IRA as well as a 401k because you’d have already exceeded the IRS $18,000 per year limit.)

Now I completely understand that a savings rate of 45% is a VERY extreme example and certainly not for everyone.  I’m running through these numbers simply to illustrate to you the path.  There IS a way to get there.  It’s what you choose to do to make it happen that’s your own choice.

Other Ways We Could Have Gotten There:

Like I said in the beginning, there’s a million different ways we could have crafted this example.  Increasing your 401k savings rate doesn’t have to be the only thing we change.

For example, let’s go back to the numbers it took us to accomplish our retirement in 30 years or less.  Suppose you had a rental property that was contributing a steady net income of $500 every month.  If you could depend on this income during your early retirement, that would offset the amount of money you’d need in your nest egg and allow you to only need a savings rate of 15% instead of 18%.

OR we could have kept our savings rate of 18% and dropped our number of years down from 29.5 to 27.2.  It works both ways.

Other things we could have done:

  • Creating MORE passive income streams (similar to our rental income example). Here’s a list of other ideas we’ve gone through on my blog before.
  • Paid off our house. Having no more mortgage would certainly lessen how much income we actually need each month.
  • Decreased other living expenses.
  • Held a part-time job.
  • Retire to another country.
  • And many more…

The takeaway in all of this: The answer to “Can I Retire at 55” is possible.  Financial freedom is possible.  But getting there isn’t something that’s just going to happen.  There are no shortcuts to early retirement planning.  Though it can take a little thought, planning, and execution, it’s totally possible to devise a strategy that can and will work.

Readers – Do you believe it’s possible to retire early under an income of $50,000 or so?  What do you think of this model?  How would you help someone at this income level to retire by age 55 or sooner?

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